382 ❖ Chapter 21/The Theory of Consumer Choice
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initial indifference curve at point C. The movement from point A to C represents the
substitution effect. Because cheese became more expensive, the consumer substitutes wine
for cheese as she moves from point A to C. The movement from point C to B represents an
7. An increase in the price of cheese could induce a consumer to buy more cheese if cheese is a
Giffen good. In that case, the income effect of the rise in the price of cheese outweighs the
substitution effect and induces the consumer to buy more cheese because cheese is an
inferior good.
Quick Check Multiple Choice
1. d
2. b
3. b
4. c
5. c
6. d
Problems and Applications
1. a. Figure 10 shows the effect of the frost on Jennifer’s budget constraint. Because the price
b. If the substitution effect outweighs the income effect for croissants, Jennifer buys more
croissants and less coffee, as shown in Figure 10. She moves from point A to point B.
Figure 10
Chapter 21/The Theory of Consumer Choice ❖ 383
Figure 11
b. Indifference curves between Coke and Pepsi are fairly straight, because there is little to
distinguish them, so they are nearly perfect substitutes. Indifference curves between skis
and ski bindings are very bowed, because they are complements.
Figure 12
3. a. Figure 12 shows the effects of these price changes. If you are equally happy, you will
remain on the same indifference curve. However, both the increase in the price of soda
b. You will consume less soda and more pizza. Since you remain equally happy, there is
only the substitution effect to consider.
384 ❖ Chapter 21/The Theory of Consumer Choice
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c. You can no longer afford your initial bundle. It lies outside of your new budget
constraint.
4. a. Cheese and crackers cannot both be inferior goods, because if Mario’s income rises he
must consume more of something.
Figure 13
5. a. Figure 13 shows Jim’s budget constraint. The vertical intercept is 50 quarts of milk,
because if Jim spent all his money on milk he would buy $100/$2 = 50 quarts of it. The
would buy $100/$4 = 25 dozen cookies.
b. If Jim’s salary rises by 10 percent to $110 and the prices of milk and cookies rise by 10
unchanged, Jim’s optimal consumption is unchanged.
6. a. This statement is true. All Giffen goods are inferior goods. It is impossible to have a
Giffen good that is a normal good.
income effect outweighs the substitution effect.
7. a. Figure 14 shows the student’s budget constraint. If she spends equal amounts on both
goods, she will purchase 5 meals in the dining hall and 20 packages of Cup O’ Soup
represented by point A.
Chapter 21/The Theory of Consumer Choice ❖ 385
Figure 14
b. If the price of Cup O’ Soup rises to $2, the student’s budget constraint will get flatter
(see Figure 15). She will now spend $18 on dining hall meals (purchasing 3) and $42 on
Cup O’ Soup (purchasing 21 packages).
Figure 15
A
386 ❖ Chapter 21/The Theory of Consumer Choice
d. Figure 16 shows the student’s demand for Cup O’ Soup. It is upward sloping, indicating
Figure 16
Figure 17 Figure 18
Budget constraint
BC
2 shows the budget constraint with a 15 percent tax.
Chapter 21/The Theory of Consumer Choice ❖ 387
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leisure) is smaller than the substitution effect (more leisure), so there is more leisure
overall. Figure 20 shows indifference curves for which a person will work the same
number of hours after the tax because the income effect (less leisure) equals the
substitution effect (more leisure), so there is the same amount of leisure overall.
Figure 19 Figure 20
9. Figure 21 shows Sarah’s budget constraints and indifference curves if she earns $6 (
BC
1), $8
wage of $8 per hour, she works 100 –
L
8 hours; and at a wage of $10 per hour, she works
$6 and $8 per hour,
L
6 >
L
8; because the labor supply curve is backward sloping when the
wage is between $8 and $10 per hour,
L
10 >
L
8.
Figure 21 Figure 22
388 ❖ Chapter 21/The Theory of Consumer Choice
effect increases consumption and reduces leisure. But the higher wage has an income effect
that increases both consumption and leisure if both are normal goods. The only way that
consumption could decrease when the wage increased would be if consumption is an inferior
11. a. Figure 23 shows the budget constraint. The initial budget line is shown as BL1. If all
hours are spent raising children, 10 children can be raised. If all hours are spent working,
Figure 23
effect of the increased wage will mean a rise in both children and consumption. The full
effect on consumption is positive, but the end effect on children depends on the relative
sizes of the income and substitution effects.
the income effect.
12. If consumers do not buy less of a good when their incomes rise, the good in question must
13. Utility is maximized when the marginal utility per dollar spent is equal across goods. Claire
Chapter 21/The Theory of Consumer Choice ❖ 389
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per dollar spent on pears than on apples. He should reallocate his budget as well, increasing
his purchases of pears and reducing his purchases of apples.